Sunday, January 26, 2014

Since the financial crisis, increasingly, U.S. Treasury issuance has occurred at the short end of the interest rate curve. Unlike many mortgage borrowers who refinanced their mortgage debt to lock in lower long term interest rates, the government has issued a majority of new debt at the short end of the interest rate curve.

The consequence of this short term structure is the negative impact higher interest rates will have on the U.S. budget. As the below chart shows, 6% of the government's budget goes toward paying interest on the U.S. debt outstanding.

With the outstanding debt now totaling over $17 trillion, a one percentage point rise in interest rates equates to an additional $170 billion in interest payments on the outstanding debt or 75% increase.

In just the last year and a half, the 5-year yield has increased over one full percentage point. And as the below chart indicates, it is not inconceivable that this rate can move much higher over time. In a lead up to the financial crisis, the 5-year yield was over 5% and just recently broke resistance.

Aside from the fact the U.S government's debt continues to grow unabated and will certainly need to be addressed sooner versus later, the issue to play out near term is in Washington, DC. It is projected the U.S. government will reach its debt ceiling limit in early February. Ultimately, Congress will certainly increase the debt limit as they always do; however, the negative news flow might impact the equity markets in the short term.

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